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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
- --------------------------------------------------------------------------------
FORM 10-Q
Registrant meets the conditions set forth in General Instruction H (1)(a) and
(b) of Form 10-Q and is therefore filing this Form with the reduced disclosure
format.
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF
THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 000-31248
ALLSTATE LIFE INSURANCE COMPANY
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
ILLINOIS 36-2554642
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
3100 SANDERS ROAD 60062
NORTHBROOK, ILLINOIS (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 847/402-5000
INDICATE BY CHECK MARK WHETHER THE REGISTRANT: (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS.
YES /X/ NO / /
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS
DEFINED IN RULE 12B-2 OF THE EXCHANGE ACT).
YES / / NO /X/
AS OF APRIL 30, 2004, THE REGISTRANT HAD 23,800 COMMON SHARES, $227 PAR VALUE,
OUTSTANDING, ALL OF WHICH ARE HELD BY ALLSTATE INSURANCE COMPANY.
ALLSTATE LIFE INSURANCE COMPANY
INDEX TO QUARTERLY REPORT ON FORM 10-Q
MARCH 31, 2004
PAGE
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements of Operations for the Three-Month Periods 1
Ended March 31, 2004 and 2003 (unaudited)
Condensed Consolidated Statements of Financial Position as of March 31, 2004 2
(unaudited) and December 31, 2003
Condensed Consolidated Statements of Cash Flows for the Three-Month Periods 3
Ended March 31, 2004 and 2003 (unaudited)
Notes to Condensed Consolidated Financial Statements (unaudited) 4
Independent Accountants' Review Report 11
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations 12
Item 4. Controls and Procedures 24
PART II OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 6. Exhibits and Reports on Form 8-K 25
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED
MARCH 31,
--------------------------
(IN MILLIONS) 2004 2003
------------ ------------
(Unaudited)
REVENUES
Premiums $ 151 $ 317
Contract charges 234 209
Net investment income 783 760
Realized capital gains and losses (27) (42)
------------ ------------
1,141 1,244
COSTS AND EXPENSES
Contract benefits 336 467
Interest credited to contractholder funds 449 432
Amortization of deferred policy acquisition costs 115 172
Operating costs and expenses 102 121
------------ ------------
1,002 1,192
Loss on disposition of operations (3) --
------------ ------------
INCOME FROM OPERATIONS BEFORE INCOME TAX EXPENSE AND CUMULATIVE
EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE, AFTER-TAX 136 52
Income tax expense 45 13
------------ ------------
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE, AFTER-TAX 91 39
Cumulative effect of change in accounting principle, after-tax (175) --
------------ ------------
NET (LOSS) INCOME $ (84) $ 39
============ ============
See notes to condensed consolidated financial statements.
1
ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
MARCH 31, DECEMBER 31,
2004 2003
------------ ------------
(IN MILLIONS, EXCEPT PAR VALUE DATA) (Unaudited)
ASSETS
Investments
Fixed income securities, at fair value (amortized cost $50,198 and $48,401) $ 54,317 $ 51,578
Mortgage loans 6,573 6,354
Equity securities 260 164
Short-term 1,319 765
Policy loans 682 686
Other 443 442
------------ ------------
Total investments 63,594 59,989
Cash 152 121
Deferred policy acquisition costs 2,672 3,202
Reinsurance recoverables, net 1,310 1,185
Accrued investment income 591 567
Other assets 351 323
Separate Accounts 13,550 13,425
------------ ------------
TOTAL ASSETS $ 82,220 $ 78,812
============ ============
LIABILITIES
Contractholder funds $ 46,997 $ 44,914
Reserve for life-contingent contract benefits 10,919 10,480
Unearned premiums 29 32
Payable to affiliates, net 112 114
Other liabilities and accrued expenses 3,462 2,594
Deferred income taxes 623 779
Long-term debt 45 45
Separate Accounts 13,550 13,425
------------ ------------
TOTAL LIABILITIES 75,737 72,383
------------ ------------
COMMITMENTS AND CONTINGENT LIABILITIES (NOTE 3)
SHAREHOLDER'S EQUITY
Redeemable preferred stock - series A, $100 par value, 1.5 million shares
authorized, 815,460 shares issued and outstanding 82 82
Common stock, $227 par value, 23,800 shares authorized and outstanding 5 5
Additional capital paid-in 1,067 1,067
Retained income 4,113 4,222
Accumulated other comprehensive income:
Unrealized net capital gains and losses and net gains and losses on
derivative financial instruments 1,216 1,053
------------ ------------
TOTAL ACCUMULATED OTHER COMPREHENSIVE INCOME 1,216 1,053
------------ ------------
TOTAL SHAREHOLDER'S EQUITY 6,483 6,429
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $ 82,220 $ 78,812
============ ============
See notes to condensed consolidated financial statements.
2
ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED
MARCH 31,
------------------
(IN MILLIONS) 2004 2003
------- -------
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES
Net (loss) income $ (84) $ 39
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization and other non-cash items (32) (45)
Realized capital gains and losses 27 42
Cumulative effect of change in accounting principle 175 --
Interest credited to contractholder funds 449 432
Changes in:
Contract benefit and other insurance reserves (65) 63
Unearned premiums -- 2
Deferred policy acquisition costs (52) 26
Reinsurance recoverables, net (46) (12)
Income taxes payable 42 (14)
Other operating assets and liabilities (7) 56
------- -------
Net cash provided by operating activities 407 589
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales
Fixed income securities 1,571 1,456
Equity securities 26 14
Investment collections
Fixed income securities 946 1,065
Mortgage loans 161 132
Investment purchases
Fixed income securities (4,112) (3,728)
Equity securities (89) (11)
Mortgage loans (362) (208)
Change in short-term investments, net 182 (7)
Change in other investments, net (21) (24)
------- -------
Net cash used in investing activities (1,698) (1,311)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Contractholder fund deposits 2,743 1,745
Contractholder fund withdrawals (1,396) (1,022)
Dividends paid (25) (1)
------- -------
Net cash provided by financing activities 1,322 722
------- -------
NET INCREASE IN CASH 31 -
CASH AT BEGINNING OF THE PERIOD 121 252
------- -------
CASH AT END OF PERIOD $ 152 $ 252
======= =======
See notes to condensed consolidated financial statements.
3
ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements include the
accounts of Allstate Life Insurance Company ("ALIC") and its wholly owned
subsidiaries (together with ALIC, the "Company"). ALIC is wholly owned by
Allstate Insurance Company ("AIC"), a wholly owned subsidiary of The Allstate
Corporation (the "Corporation").
The condensed consolidated financial statements and notes as of March 31,
2004 and for the three-month periods ended March 31, 2004 and 2003 are
unaudited. The condensed consolidated financial statements reflect all
adjustments (consisting only of normal recurring accruals) which are, in the
opinion of management, necessary for the fair presentation of the financial
position, results of operations and cash flows for the interim periods. These
condensed consolidated financial statements and notes should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2003. The results of operations for the interim periods should not be
considered indicative of results to be expected for the full year.
To conform to the 2004 presentation, certain amounts in the prior year's
condensed consolidated financial statements and notes have been reclassified.
Equity securities include common stocks, non-redeemable preferred stocks
and limited partnership interests. Common stocks and non-redeemable preferred
stocks had a carrying value of $146 million and $83 million, and cost of $142
million and $79 million at March 31, 2004 and December 31, 2003, respectively.
Investments in limited partnership interests had a carrying value of $114
million and $81 million, and a cost of $114 million and $81 million at March 31,
2004 and December 31, 2003, respectively.
Non-cash investment exchanges and modifications, which primarily reflect
refinancings of fixed income securities, totaled $1 million and $34 million for
the three months ended March 31, 2004 and 2003, respectively.
ADOPTED ACCOUNTING STANDARD
STATEMENT OF POSITION 03-1, "ACCOUNTING AND REPORTING BY INSURANCE ENTERPRISES
FOR CERTAIN NONTRADITIONAL LONG-DURATION CONTRACTS AND FOR SEPARATE ACCOUNTS"
("SOP 03-1")
On January 1, 2004, the Company adopted SOP 03-1. The major provisions of
the SOP affecting the Company require:
- Establishment of reserves primarily related to death benefit and income
benefit guarantees provided under variable annuity contracts;
- Deferral of sales inducements that meet certain criteria, and
amortization using the same method used for deferred policy acquisition
costs ("DAC"); and
- Reporting and measuring assets and liabilities of certain separate
accounts products as investments and contractholder funds rather than
as separate accounts assets and liabilities when specified criteria are
present.
EFFECTS OF ADOPTION
The cumulative effect of the change in accounting principle from
implementing SOP 03-1 was a loss of $175 million, after-tax ($269 million,
pre-tax). It was comprised of an increase in benefits reserves (primarily for
variable annuity contracts) of $145 million, pre-tax, and a reduction in DAC and
deferred sales inducements ("DSI") of $124 million, pre-tax.
The SOP requires consideration of a range of potential results to estimate
the cost of variable annuity death benefits and income benefits, which generally
necessitates the use of stochastic modeling techniques. To maintain consistency
with the assumptions used in the establishment of reserves for variable annuity
guarantees, the Company utilized the results of this stochastic modeling to
estimate expected gross profits, which form the basis for determining the
amortization of DAC and DSI. This new modeling approach resulted in a lower
estimate of expected gross profits, and therefore resulted in a write-down of
DAC and DSI.
4
ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In 2004, DSI and related amortization is classified within the Condensed
Consolidated Statements of Financial Position and Operations as other assets and
interest credited to contractholder funds, respectively. The amounts are
provided below.
The Company reclassified $204 million of separate accounts assets and
liabilities to investments and contractholder funds, respectively.
LIABILITIES FOR CONTRACT GUARANTEES
The Company offers various guarantees to variable contractholders including
a return of no less than (a) total deposits made on the contract less any
customer withdrawals, (b) total deposits made on the contract less any customer
withdrawals plus a minimum return or (c) the highest contract value on a
specified anniversary date minus any customer withdrawals following the contract
anniversary. These guarantees include benefits that are payable in the event of
death, upon annuitization, or at specified dates during the accumulation period.
The table below presents information regarding the Company's variable
contracts with guarantees. The Company's variable annuity contracts may offer
more than one type of guarantee in each contract; therefore, the sum of amounts
listed exceeds the total account balances of variable annuity contracts'
separate accounts with guarantees.
($ IN MILLIONS) MARCH 31, 2004
--------------
IN THE EVENT OF DEATH
Account value $ 13,346
Net amount at risk (1) $ 2,312
Average attained age of contractholders 63 years
AT ANNUITIZATION
Account value $ 3,697
Net amount at risk (2) $ 15
Weighted average waiting period until annuitization options available 8 years
ACCUMULATION AT SPECIFIED DATES
Account value $ 86
Net amount at risk (3) $ -
Weighted average waiting period until guarantee date 11 years
(1) Defined as the current guaranteed minimum death benefit in excess of
the current account balance at the balance sheet date.
(2) Defined as the present value of the minimum guaranteed annuity
payments determined in accordance with the terms of the contract in
excess of the current account balance.
(3) Defined as the present value of the guaranteed minimum accumulation
balance in excess of the current account balance.
Account balances of variable contracts' separate accounts with guarantees
were invested as follows:
(IN MILLIONS) MARCH 31, 2004
--------------
Equity securities (including mutual funds) $ 12,710
Cash and cash equivalents 636
------------
Total variable contracts' separate account assets with guarantees $ 13,346
============
5
ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table summarizes the liabilities for guarantees:
LIABILITY FOR LIABILITY FOR
GUARANTEES GUARANTEES
RELATED TO DEATH RELATED TO INCOME
(IN MILLIONS) BENEFITS BENEFITS TOTAL
----------------- ----------------- -----------------
Balance at January 1, 2004 $ 117 $ 41 $ 158
Less reinsurance recoverables (11) (2) (13)
----------------- ----------------- -----------------
Net balance at January 1, 2004 106 39 145
Incurred guaranteed benefits 13 2 15
Paid guarantee benefits (17) - (17)
----------------- ----------------- -----------------
Net change (4) 2 (2)
Net balance at March 31, 2004 102 41 143
Plus reinsurance recoverables 11 2 13
----------------- ----------------- -----------------
Balance, March 31, 2004(1) $ 113 $ 43 $ 156
================= ================= =================
(1) Included in the total reserve balance are reserves for variable annuity
death benefits of $99 million, variable annuity income benefits of $17
million and other guarantees of $40 million.
The liability for death and income benefit guarantees is established equal
to a benefit ratio multiplied by the cumulative contract charges earned, plus
accrued interest less contract benefit payments. The benefit ratio is calculated
as the estimated present value of all expected contract benefits divided by the
present value of all expected contract charges. For guarantees in the event of
death, benefits represent the current guaranteed minimum death payments in
excess of the current account balance. For guarantees at annuitization, benefits
represent the present value of the minimum guaranteed annuity benefits in excess
of the current account balance.
Projected benefits and contract charges used in determining the liability
for guarantees are developed using models and stochastic scenarios that are also
used in the development of estimated expected gross profits. Underlying
assumptions for the liability related to income benefits include assumed future
annuitization elections based on factors such as the extent of benefit to the
potential annuitant, eligibility conditions and the annuitant's attained age.
The liability for guarantees will be re-evaluated periodically, and
adjustments will be made to the liability balance through a charge or credit to
contract benefits.
DEFERRED SALES INDUCEMENTS
Costs related to sales inducements offered on sales to new customers,
principally on investment contracts and primarily in the form of additional
credits to the customer's account value or enhancements to interest credited for
a specified period, which are beyond amounts currently being credited to
existing contracts, are deferred and recorded as other assets. All other sales
inducements are expensed as incurred and included in interest credited to
contractholder funds on the Condensed Consolidated Statements of Operations. DSI
is amortized to income using the same methodology and assumptions as DAC, and
included in interest credited to contractholder funds. DSI is periodically
reviewed for recoverability and written down when necessary.
DSI activity for the three months ended March 31, 2004 was as follows:
(IN MILLIONS)
Balance, January 1, 2004 $ 182
Sales inducements deferred 12
Amortization charged to income (13)
Effects of unrealized gains and losses (113)
------------
Balance, March 31, 2004 $ 68
============
6
ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
PENDING ACCOUNTING STANDARD
EMERGING ISSUES TASK FORCE TOPIC NO. 03-01, "THE MEANING OF OTHER-THAN-TEMPORARY
IMPAIRMENT AND ITS APPLICATION TO CERTAIN INVESTMENTS" ("EITF NO. 03-01")
In March 2004, the Emerging Issues Task Force ("EITF") reached a final
consensus on EITF No. 03-01, which is effective for reporting periods beginning
after June 15, 2004. EITF No. 03-01 requires that when the fair value of an
investment security is less than its carrying value an impairment exists for
which a determination must be made as to whether the impairment is
other-than-temporary. An impairment loss should be recognized equal to the
difference between the investment's carrying value and its fair value when an
impairment is other-than-temporary. The EITF No. 03-01 impairment model applies
to all investment securities accounted for under Statement of Financial
Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in
Debt and Equity Securities" and to investment securities accounted for under the
cost method to the extent an impairment indicator exists or the reporting entity
has estimated the fair value of the investment security in connection with SFAS
No. 107, "Disclosures about Fair Value of Financial Instruments". The
disclosures required for investment securities accounted for under the cost
method are effective for fiscal years ending after June 15, 2004. The adoption
of EITF No. 03-01 is not expected to result in a material change in the
Company's Condensed Consolidated Statements of Operations or Financial Position.
2. REINSURANCE
The effects of reinsurance on premiums and contract charges are as follows:
THREE MONTHS ENDED
MARCH 31,
----------------------------
2004 2003
------------ ------------
(IN MILLIONS)
PREMIUMS AND CONTRACT CHARGES
Direct $ 516 $ 603
Assumed
Affiliate 4 6
Non-affiliate 5 22
Ceded--non-affiliate (140) (105)
------------ ------------
Premiums and contract charges, net of reinsurance $ 385 $ 526
============ ============
The effects of reinsurance on contract benefits are as follows:
THREE MONTHS ENDED
MARCH 31,
----------------------------
2004 2003
------------ ------------
(IN MILLIONS)
CONTRACT BENEFITS
Direct $ 415 $ 530
Assumed
Affiliate 2 -
Non-affiliate - 10
Ceded
Non-affiliate (81) (73)
------------ ------------
Contract benefits, net of reinsurance $ 336 $ 467
============ ============
7
ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
3. GUARANTEES AND CONTINGENT LIABILITIES
GUARANTEES
The Company owns certain fixed income securities that obligate the Company
to exchange credit risk or to forfeit principal due, depending on the nature or
occurrence of specified credit events for the referenced entities. Additionally,
the Company has written credit default swaps that obligate the Company to make a
payment upon the occurrence of specified credit events. In the event all such
specified credit events were to occur, the Company's maximum amount at risk on
these fixed income securities and written credit default swaps, as measured by
the par value and notional value, respectively, was $197 million at March 31,
2004. The obligations associated with these fixed income securities and written
credit default swaps expire at various times during the next seven years.
Lincoln Benefit Life Company ("LBL"), a wholly owned subsidiary of ALIC,
has issued universal life insurance contracts to third parties who finance the
premium payments on the universal life insurance contracts through a commercial
paper program. LBL has issued a repayment guarantee on the outstanding
commercial paper balance that is fully collateralized by the cash surrender
value of the universal life insurance contracts. At March 31, 2004, the amount
due under the commercial paper program is $300 million and the cash surrender
value of the policies is $307 million. The repayment guarantee expires April 30,
2006.
In the normal course of business, the Company provides standard
indemnifications to counterparties in contracts in connection with numerous
transactions, including indemnifications for breaches of representations and
warranties, taxes and certain other liabilities, such as third party lawsuits.
The indemnification clauses are often standard contractual terms and were
entered into in the normal course of business based on an assessment that the
risk of loss would be remote. The terms of the indemnifications vary in duration
and nature. In many cases, the maximum obligation is not explicitly stated and
the contingencies triggering the obligation to indemnify have not occurred and
are not expected to occur. Because the obligated amounts of the indemnifications
are not explicitly stated in many cases, the maximum amount of the obligation
under such indemnifications is not determinable. Historically, the Company has
not made any material payments pursuant to these obligations.
In addition, the Company and its subsidiaries indemnify their respective
directors, officers and other individuals to the extent provided in their
charters and by-laws. Since these indemnifications are generally not subject to
limitation with respect to duration or amount, the Company does not believe that
it is possible to determine the maximum potential amount due under these
indemnifications.
The aggregate liability balance related to all guarantees was not material
as of March 31, 2004.
REGULATION
The Company is subject to changing social, economic and regulatory
conditions. Recent state and federal regulatory initiatives and proceedings have
included efforts to remove barriers preventing banks from engaging in the
securities and insurance businesses, change tax laws affecting the taxation of
insurance companies and the tax treatment of insurance products or competing
non-insurance products that may impact the relative desirability of various
personal investment products and otherwise expand overall regulation of
insurance products and the insurance industry. The ultimate changes and eventual
effects of these initiatives on the Company's business, if any, are uncertain.
LEGAL PROCEEDINGS
As described below, the Company is named as a defendant in a number of
lawsuits and other legal proceedings arising out of various aspects of its
business. These matters raise difficult and complicated factual and legal issues
and are subject to many uncertainties and complexities, including but not
limited to, the underlying facts of each matter, novel legal issues, variations
between jurisdictions in which matters are being litigated, differences in
applicable laws and judicial interpretations, the length of time before many of
these matters might be resolved by settlement or through litigation and, in some
cases, the timing of their resolutions relative to other similar cases brought
against other companies, the fact that some of these matters are putative class
actions in which the purported class is not clearly defined, the fact that some
of these matters involve multi-state class actions in which the applicable
law(s) for the claims at issue is in dispute and therefore unclear, and the
current challenging legal environment faced by large corporations and insurance
companies.
8
ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In these matters, plaintiffs seek a variety of remedies including equitable
relief in the form of injunctive and other remedies and monetary relief in the
form of contractual and extra-contractual damages. In some cases, the monetary
damages sought include punitive or treble damages or are not specified. Often
more specific information beyond the type of relief sought is not available
because plaintiffs have not requested more specific relief in their court
pleadings. In those cases where plaintiffs have made a specific demand for
monetary damages, whether to support minimum jurisdictional requirements or
otherwise, it is our experience that such demands may be misleading indicators
of what the ultimate loss, if any, will be to the Company.
It is not possible to make meaningful estimates of the amount or range of
loss that could result from these matters. The Company reviews these matters on
an on-going basis. In the opinion of the Company's management, while some of
these matters may be material to the Company's operating results for any
particular period if an unfavorable outcome results, none will have a material
adverse effect on the consolidated financial condition of the Company.
Legal proceedings involving Allstate agencies and AIC may impact the
Company, even when the Company is not directly involved, because the Company
sells its products through a variety of distribution channels including Allstate
agencies. Consequently, information about the more significant of these
proceedings is provided below.
AIC is defending various lawsuits involving worker classification issues.
These lawsuits include a number of putative class actions and one certified
class action challenging the overtime exemption claimed by AIC under the Fair
Labor Standards Act or state wage and hour laws. Plaintiffs seek monetary
relief, such as penalties and liquidated damages, and non-monetary relief, such
as injunctive relief and an accounting. These class actions mirror similar
lawsuits filed recently against other carriers in the industry and other
employers. A putative nationwide class action filed by former employee agents
also includes a worker classification issue; these agents are challenging
certain amendments to the Agents Pension Plan and are seeking to have exclusive
agent independent contractors treated as employees for benefit purposes. AIC has
been vigorously defending these and various other worker classification
lawsuits. The outcome of these disputes is currently uncertain.
AIC is also defending certain matters relating to its agency program
reorganization announced in 1999. These matters include an investigation by the
U.S. Department of Labor, a lawsuit filed in December 2001 by the U.S. Equal
Employment Opportunity Commission ("EEOC") alleging retaliation under federal
civil rights laws and a class action filed in August 2001 by former employee
agents alleging retaliation under the Age Discrimination in Employment Act,
breach of contract and ERISA violations. In March 2004, in the EEOC and class
action lawsuits, the trial court issued a memorandum and order that, among other
things, certified classes of agents, including a mandatory class of agents who
had signed a release for purposes of effecting the court's declaratory judgment
that the release is voidable at the option of the release signer. The court also
ordered that an agent who voids the release must return to AIC "any and all
benefits received by the [agent] in exchange for signing the release." The court
also "concluded that, on the undisputed facts of record, there is no basis for
claims of age discrimination." The EEOC and plaintiffs have asked the court to
clarify and/or reconsider its memorandum and order. The case otherwise remains
pending. A putative nationwide class action has also been filed by former
employee agents alleging various violations of ERISA. This matter was dismissed
with prejudice in March 2004 by the trial court but will be the subject of
further proceedings, which may include appeals. In these matters, plaintiffs
seek compensatory and punitive damages, and equitable relief. AIC has been
vigorously defending these lawsuits and other matters related to its agency
program reorganization. In addition, AIC is defending certain matters relating
to its life agency program reorganization announced in 2000. These matters
include an investigation by the EEOC with respect to allegations of age
discrimination and retaliation. AIC is cooperating fully with the agency
investigation and will continue to vigorously defend these and other claims
related to the life agency program reorganization. The outcome of these disputes
is currently uncertain.
The Company is defending various lawsuits and regulatory proceedings that
allege that it engaged in business or sales practices inconsistent with state or
federal law. Plaintiffs seek a variety of remedies including monetary and
equitable relief. The Company has been vigorously defending these matters, but
their outcome is currently uncertain.
Various other legal and regulatory actions are currently pending that
involve the Company and specific aspects of its conduct of business. Like other
members of the insurance industry, the Company is the target of an increasing
9
ALLSTATE LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
number of class action lawsuits and other types of litigation, some of which
involve claims for substantial or indeterminate amounts. This litigation is
based on a variety of issues including insurance and claim settlement practices.
The outcome of these disputes is currently unpredictable. However, at this time,
based on their present status, it is the opinion of management that the ultimate
liability, if any, in one or more of these other actions in excess of amounts
currently reserved is not expected to have a material effect on the results of
operations, liquidity or financial position of the Company.
4. OTHER COMPREHENSIVE INCOME
The components of other comprehensive income on a pretax and after-tax
basis are as follows:
THREE MONTHS ENDED
MARCH 31,
-----------------------------------------------------------------
2004 2003
------------------------------- -------------------------------
AFTER- AFTER-
(IN MILLIONS) PRETAX TAX TAX PRETAX TAX TAX
-------- -------- -------- -------- -------- --------
UNREALIZED NET CAPITAL GAINS AND LOSSES AND NET GAINS
AND LOSSES ON DERIVATIVE FINANCIAL INSTRUMENTS
Unrealized holding gains (losses) arising
during the period $ 224 $ (78) $ 146 $ 98 $ (34) $ 64
Less: reclassification adjustments (30) 11 (19) (53) 19 (34)
-------- -------- -------- -------- -------- --------
Unrealized net capital gains (losses) 254 (89) 165 151 (53) 98
-------- -------- -------- -------- -------- --------
Net gains (losses) on derivative financial
instruments arising during the period - - - - - -
Less: reclassification adjustments 3 (1) 2 - - -
-------- -------- -------- -------- -------- --------
Net gains (losses) on derivative financial instruments (3) 1 (2) - - -
-------- -------- -------- -------- -------- --------
Other comprehensive income (loss) $ 251 $ (88) 163 $ 151 $ (53) 98
======== ======== ======== ========
Net income (loss) (84) 39
-------- --------
Comprehensive income (loss) $ 79 $ 137
======== ========
10
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
To the Board of Directors and Shareholder of
Allstate Life Insurance Company:
We have reviewed the accompanying condensed consolidated statement of
financial position of Allstate Life Insurance Company and subsidiaries (the
"Company", an affiliate of The Allstate Corporation) as of March 31, 2004, and
the related condensed consolidated statements of operations and cash flows for
the three-month periods ended March 31, 2004 and 2003. These interim financial
statements are the responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and of making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with auditing standards generally accepted in the United States of
America, the objective of which is the expression of an opinion regarding the
financial statements taken as a whole. Accordingly, we do not express such an
opinion.
Based on our reviews, we are not aware of any material modifications that
should be made to such condensed consolidated financial statements for them to
be in conformity with accounting principles generally accepted in the United
States of America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated statement of
financial position of Allstate Life Insurance Company and subsidiaries as of
December 31, 2003, and the related consolidated statements of operations and
comprehensive income, shareholder's equity, and cash flows for the year then
ended, not presented herein. In our report dated February 4, 2004, which report
includes an explanatory paragraph as to changes in the Company's methods of
accounting for embedded derivatives in modified coinsurance agreements and
variable interest entities in 2003, we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the information set forth in
the accompanying condensed consolidated statement of financial position as of
December 31, 2003 is fairly stated, in all material respects, in relation to the
consolidated statement of financial position from which it has been derived.
/s/ Deloitte & Touche LLP
Chicago, Illinois
May 7, 2004
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE THREE-MONTH PERIOD ENDED MARCH 31, 2004 AND 2003
OVERVIEW
The following discussion highlights significant factors influencing the
consolidated financial position and results of operations of Allstate Life
Insurance Company (referred to in this document as "we", "our", "us", or the
"Company"). It should be read in conjunction with the condensed consolidated
financial statements and notes thereto found under Part I. Item 1. contained
herein, and with the discussion, analysis, consolidated financial statements and
notes thereto in Part I. Item 1. and Part II. Item 7. and Item 8. of the
Allstate Life Insurance Company Annual Report on Form 10-K for 2003. We operate
as a single segment entity, based on the manner in which financial information
is used internally to evaluate performance and determine the allocation of
resources.
HIGHLIGHTS
- - Revenues decreased 8.3% in the first quarter of 2004 compared to the same
period of 2003. This decrease was primarily due to lower sales of immediate
annuities with life contingencies and the disposal of the majority of our
direct response distribution business. The decrease was partially offset by
higher net investment income and contract charges and lower net realized
capital losses.
- - We had a net loss of $84 million for the first quarter of 2004 compared to
net income of $39 million for the same period of 2003. This decline was
primarily due to a $175 million after-tax charge related to the cumulative
effect of a change in accounting principle for the adoption of AICPA
Statement of Position 03-1, "Accounting and Reporting by Insurance
Enterprises for Certain Nontraditional Long-Duration Contracts and for
Separate Accounts" ("SOP 03-1"). Excluding the cumulative effect of change
in accounting principle, after-tax, net income improved 133.3% over the
first quarter of 2003. The improvement was primarily attributable to lower
amortization of DAC and deferred sales inducements ("DSI"), which was
primarily the result of amortization acceleration of $53 million,
after-tax, in the first quarter of 2003.
- - Investments, including separate accounts assets, increased 17.7% to $77.14
billion at March 31, 2004 compared to March 31, 2003, due primarily to
strong contractholder funds deposits and increases in separate accounts
balances resulting from improved equity market performance during the
preceding year.
- - Contractholder funds deposits totaled $2.74 billion for the first quarter
of 2004 compared to $1.75 billion in the same period of 2003. The increase
of $998 million was primarily attributable to institutional products.
- - The disposal of the majority of our direct response distribution business
resulted in declines in total revenues of $59 million, operating costs and
expenses of $23 million, amortization of DAC of $8 million and net income
of $5 million. The revenue decrease also contributed to a decline in the
mortality margin of $35 million in the first quarter of 2004 when compared
to the first quarter of 2003.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE THREE-MONTH PERIOD ENDED MARCH 31, 2004 AND 2003
OPERATIONS
PREMIUMS represent revenues generated from traditional life, immediate annuities
with life contingencies and other insurance products that have significant
mortality or morbidity risk.
CONTRACT CHARGES are revenues generated from interest-sensitive life products,
variable annuities, fixed annuities and other investment products for which
deposits are classified as contractholder funds or separate accounts liabilities
on the Condensed Consolidated Statements of Financial Position. Contract charges
are assessed against the contractholder account values for maintenance,
administration, cost of insurance and surrender prior to contractually specified
dates. As a result, changes in contractholder funds and separate accounts
liabilities are considered in the evaluation of growth and as indicators of
future levels of revenues.
The following table summarizes premiums and contract charges by product.
THREE MONTHS ENDED
MARCH 31,
-----------------------
(IN MILLIONS) 2004 2003
---------- --------
PREMIUMS
Traditional life $ 74 $ 91
Immediate annuities with life contingencies 77 183
Other - 43
---------- --------
TOTAL PREMIUMS 151 317
CONTRACT CHARGES
Interest-sensitive life 160 150
Fixed annuities 14 7
Variable annuities 60 47
Institutional products - 3
Other - 2
---------- --------
TOTAL CONTRACT CHARGES 234 209
---------- --------
TOTAL PREMIUMS AND CONTRACT CHARGES $ 385 $ 526
========== ========
The following table summarizes premiums and contract charges by
distribution channel.
THREE MONTHS ENDED
MARCH 31,
------------------------
(IN MILLIONS) 2004 2003
----------- --------
PREMIUMS
Allstate agencies $ 53 $ 53
Specialized brokers 63 183
Independent agents 20 7
Direct marketing 15 74
----------- --------
TOTAL PREMIUMS 151 317
CONTRACT CHARGES
Allstate agencies 113 109
Specialized brokers 7 7
Independent agents 59 49
Financial institutions and broker/dealers 54 44
Direct marketing 1 -
----------- --------
TOTAL CONTRACT CHARGES 234 209
----------- --------
TOTAL PREMIUMS AND CONTRACT CHARGES $ 385 $ 526
=========== ========
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE THREE-MONTH PERIOD ENDED MARCH 31, 2004 AND 2003
Total premiums decreased 52.4% to $151 million in the first quarter of 2004
compared to the same period of 2003. The decrease was primarily the result of
lower premiums on immediate annuities with life contingencies, the disposal of
the majority of our direct response distribution business and decreased
traditional life premiums. The decline in immediate annuities with life
contingencies was primarily the result of underwriting actions to reduce the
size of certain types of individual contracts sold. The decline in traditional
life premium reflects a shift in product sales from traditional whole life
policies to term insurance, which has lower premiums and utilizes more
reinsurance.
Contract charges increased 12.0% to $234 million in the first quarter of
2004 compared to the same period of 2003. The increase was primarily due to
higher contract charges on variable annuities as a result of overall higher
account values during the first quarter of 2004 compared to the prior period and
increased contract charges on interest-sensitive life products resulting from in
force business growth. Variable annuity contract charges, as a percent of
average separate account values, increased to 168 basis points in the first
quarter of 2004 from 164 basis points in the same period of 2003 as a result of
increases in benefit rider fee rates and increased rider utilization by
contractholders.
Contractholder funds represent interest-bearing liabilities arising from
the sale of individual products, such as interest-sensitive life, fixed
annuities and institutional products, such as funding agreements. The balance of
contractholder funds is equal to the cumulative deposits received and interest
credited to the contractholder less cumulative contract maturities, benefits,
surrenders, withdrawals and contract charges for mortality or administrative
expenses.
The following table shows the changes in contractholder funds.
THREE MONTHS ENDED MARCH 31,
------------------------------
(IN MILLIONS) 2004 2003
---------- ----------
CONTRACTHOLDER FUNDS, BEGINNING BALANCE $ 44,914 $ 38,858
Impact of adoption of SOP 03-1(1) 421 --
DEPOSITS
Fixed annuities (immediate and deferred) 1,216 1,009
Institutional products 1,101 354
Interest-sensitive life 306 210
Variable annuity and life deposits allocated to fixed accounts 120 172
---------- ----------
Total deposits 2,743 1,745
INTEREST CREDITED 444 432
MATURITIES, BENEFITS, WITHDRAWALS AND OTHER ADJUSTMENTS
Maturities of institutional products (511) (397)
Benefits and withdrawals (755) (607)
Contract charges (142) (133)
Net transfers to separate accounts (131) (23)
Fair value hedge adjustments for institutional products 23 16
Other adjustments (9) (11)
---------- ----------
Total maturities, benefits, withdrawals and other adjustments (1,525) (1,155)
---------- ----------
CONTRACTHOLDER FUNDS, ENDING BALANCE $ 46,997 $ 39,880
========== ==========
(1) The increase in contractholder funds due to the adoption of SOP 03-1
reflects the reclassification of certain products previously included as a
component of separate accounts to contractholder funds, the
reclassification of deferred sales inducements from contractholder funds to
other assets and the establishment of reserves for certain liabilities that
are primarily related to income and death benefit guarantees provided under
variable annuity contracts.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE THREE-MONTH PERIOD ENDED MARCH 31, 2004 AND 2003
Contractholder funds deposits increased 57.2% in the first quarter of 2004
compared to the same period of 2003, and average contractholder funds, after
reflecting the impact of adopting SOP 03-1, increased 17.3% due to significant
increases in institutional product and fixed annuity deposits. Institutional
products deposits increased $747 million largely due to our assessment of market
opportunities. Fixed annuity deposits increased 20.5% primarily due to
competitive pricing.
Benefits and withdrawals increased 24.4% in the first quarter of 2004
compared to the same period of 2003. Benefits and withdrawals for 2004 represent
2.2% of the beginning of period contractholder funds balance excluding
institutional product reserves, a slight increase compared to 2.1% in 2003. The
increase reflects the growth and aging of our in-force contracts as actual
surrenders and withdrawals compare favorably to our pricing assumptions.
Institutional product maturities increased $114 million in the first quarter of
2004 over the same period of last year as an increasing number of contracts
issued in prior years reached their stated maturity dates.
Separate accounts liabilities represent contractholders' claims to the
related legally segregated separate accounts assets. Separate accounts
liabilities primarily arise from the sale of variable annuity contracts and
variable life insurance policies. The following table shows the changes in
separate accounts liabilities.
THREE MONTHS ENDED
MARCH 31,
---------------------------
(IN MILLIONS) 2004 2003
----------- -----------
SEPARATE ACCOUNTS LIABILITIES, BEGINNING BALANCE $ 13,425 $ 11,125
Impact of adoption of SOP 03-1(1) (204) --
Variable annuity and life deposits 487 425
Variable annuity and life deposits allocated to fixed accounts (120) (172)
----------- -----------
Net deposits 367 253
Investment results 316 (268)
Contract charges (62) (52)
Net transfers from fixed accounts 131 23
Surrenders and benefits (423) (528)
----------- -----------
SEPARATE ACCOUNTS LIABILITIES, ENDING BALANCE $ 13,550 $ 10,553
=========== ===========
(1) The decrease in separate accounts due to the adoption of SOP 03-1 reflects
the reclassification of certain products previously included as a component
of separate accounts to contractholder funds.
Separate accounts liabilities, after reflecting the impact of adopting SOP
03-1, increased $329 million during the first quarter of 2004 compared to a
decline of $572 million during the same period of 2003 reflecting a significant
improvement in investment results and net deposits. The increase in variable
annuity deposits resulted from increasing consumer demand due to improved equity
market performance. Variable annuity contractholders often allocate a
significant portion of their initial variable annuity contract deposit into a
fixed rate investment option. The level of this activity is reflected above in
the deposits allocated to the fixed accounts, while all other transfer activity
between the fixed and separate accounts investment options is reflected in net
transfers from fixed accounts. The liability for the fixed portion of variable
annuity contracts is reflected in contractholder funds.
NET INVESTMENT INCOME increased 3.0% in the first quarter of 2004 compared to
the same period in 2003, primarily due to the effect of higher portfolio
balances and higher income on partnership interests, partially offset by lower
portfolio yields. Higher portfolio balances resulted from the investment of cash
flows from operating and financing activities. Investment balances as of March
31, 2004, excluding unrealized net capital gains, increased 15.0% from March 31,
2003. The lower portfolio yields were primarily due to purchases of fixed income
securities with yields lower than the current portfolio average.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE THREE-MONTH PERIOD ENDED MARCH 31, 2004 AND 2003
NET INCOME analysis is presented in the following table.
THREE MONTHS ENDED
MARCH 31,
------------------------
(IN MILLIONS) 2004 2003
--------- ----------
Premiums $ 151 $ 317
Contract charges 234 209
Net investment income(1) 789 763
Contract benefits (336) (467)
Interest credited to contractholder funds(2) (436) (432)
--------- ----------
GROSS MARGIN 402 390
Amortization of DAC and DSI (113) (159)
Operating costs and expenses (102) (121)
Income tax expense (63) (34)
Realized capital gains and losses, after-tax (17) (26)
DAC and DSI amortization related to realized capital
gains and losses, after-tax (10) (9)
Reclassification of periodic settlements and accruals on non-
hedge derivative instruments, after-tax (4) (2)
Loss on disposition of operations, after-tax (2) --
Cumulative effect of change in accounting principle, after-tax (175) --
--------- ----------
NET INCOME $ (84) $ 39
========= ==========
(1) Net investment income includes periodic settlements and accruals
on non-hedge derivative instruments, pretax, totaling $6 million
for the first quarter of 2004 and $3 million for the first
quarter of 2003.
(2) Beginning in 2004, amortization of DSI is excluded from interest
credited to contractholder funds for purposes of calculating
gross margin. Amortization of DSI totaled $13 million in the
first quarter of 2004. Prior periods have not been restated.
GROSS MARGIN, a non-GAAP measure, represents premiums and contract charges
and net investment income, less contract benefits and interest credited to
contractholder funds. We use gross margin as a component of our evaluation of
the profitability of our life insurance and financial product portfolio.
Additionally, for many of our products, including fixed annuities, variable life
and annuities, and interest-sensitive life insurance, the amortization of DAC
and DSI is determined based on actual and expected gross margin. Gross margin is
comprised of four components that are utilized to further analyze the business;
they include the investment margin, mortality margin, and maintenance and
surrender charges. We believe gross margin and its components are useful to
investors because they allow for the evaluation of income components separately
and in the aggregate when reviewing performance. Gross margin, investment margin
and mortality margin should not be considered as a substitute for net income and
do not reflect the overall profitability of the business. Net income is the GAAP
measure that is most directly comparable to these margins. Gross margin is
reconciled to GAAP net income in the table above.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE THREE-MONTH PERIOD ENDED MARCH 31, 2004 AND 2003
The components of gross margin are reconciled to the corresponding financial
statement line items in the following tables.
THREE MONTHS ENDED MARCH 31, 2004
--------------------------------------------------------------------------
INVESTMENT MORTALITY MAINTENANCE SURRENDER GROSS
MARGIN MARGIN CHARGES CHARGES MARGIN
------------ ------------ ------------ ------------ ------------
Premiums $ - $ 151 $ - $ - $ 151
Contract charges - 122 92 20 234
Net investment income (1) 789 - - - 789
Contract benefits (131) (205) - - (336)
Interest credited to
contractholder funds (2) (436) - - - (436)
------------ ------------ ------------ ------------ ------------
$ 222 $ 68 $ 92 $ 20 $ 402
============ ============ ============ ============ ============
THREE MONTHS ENDED MARCH 31, 2003
--------------------------------------------------------------------------
INVESTMENT MORTALITY MAINTENANCE SURRENDER GROSS
MARGIN MARGIN CHARGES CHARGES MARGIN
------------ ------------ ------------ ------------ ------------
Premiums $ - $ 317 $ - $ - $ 317
Contract charges - 111 79 19 209
Net investment income (1) 763 - - - 763
Contract benefits (127) (340) - - (467)
Interest credited to
contractholder funds (2) (432) - - - (432)
------------ ------------ ------------ ------------ ------------
$ 204 $ 88 $ 79 $ 19 $ 390
============ ============ ============ ============ ============
(1) Net investment income includes periodic settlements and accruals on
non-hedge derivative instruments, pretax, totaling $6 million for the first
quarter of 2004 and $3 million for the first quarter of 2003.
(2) Beginning in 2004, amortization of DSI is excluded from interest credited
to contractholder funds for purposes of calculating gross margin.
Amortization of DSI totaled $13 million in the first quarter of 2004. Prior
periods have not been restated.
Gross margin increased 3.1% during the first quarter of 2004 compared to
the same period of 2003 due to increased investment margin and higher
maintenance and surrender charges, partly offset by a decrease in the mortality
margin.
INVESTMENT MARGIN is a component of gross margin, both of which are
non-GAAP measures. Investment margin represents the excess of net investment
income over interest credited to contractholder funds and the implied interest
on life-contingent immediate annuities included in the reserve for
life-contingent contract benefits. We use investment margin to evaluate
profitability related to the difference between investment returns on assets
supporting certain products and amounts credited to customers ("spread") during
a fiscal period.
Investment margin by product group is shown in the following table.
THREE MONTHS ENDED
MARCH 31,
-----------------------
(IN MILLIONS) 2004 2003
---------- ----------
Life insurance $ 44 $ 41
Annuities 148 137
Institutional products 30 26
---------- ----------
Total investment margin $ 222 $ 204
========== ==========
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE THREE-MONTH PERIOD ENDED MARCH 31, 2004 AND 2003
Investment margin increased 8.8% in the first quarter of 2004 compared to
the same period of 2003 due to a 17.8% increase in contractholder funds and
improved yields on investments supporting capital, traditional life and other
products. These increases were partially offset by a decline in fixed annuity
investment spreads as investment yield declines were not fully offset by
crediting rate reductions. The yield on the capital, traditional life and other
products investment portfolio improved due to more effective cash management and
higher investment income realized on investments accounted for using the equity
method of accounting. The weighted average interest crediting rate for the
quarter ended March 31, 2004 on fixed annuity and interest-sensitive life
products in force, excluding market value adjusted annuities, was approximately
60 basis points more than the underlying long-term guaranteed rates on these
products. The crediting rate on approximately 40% of these contracts was at the
contractually guaranteed minimum rate as of March 31, 2004.
The following table summarizes the annualized weighted average investment
yield, interest crediting rates and investment spreads for the three months
ended March 31.
WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE
INVESTMENT YIELD INTEREST CREDITING RATE INVESTMENT SPREADS
---------------- ----------------------- ------------------
2004 2003 2004 2003 2004 2003
---- ---- ---- ---- ---- ----
Interest-sensitive life 6.5% 7.1% 4.6% 5.0% 1.9% 2.1%
Fixed annuities - deferred 5.9 6.7 4.1 4.7 1.8 2.0
Fixed annuities - immediate 7.5 8.0 6.9 7.2 0.6 0.8
Institutional 3.0 3.8 2.0 2.8 1.0 1.0
Investments supporting capital,
traditional life and other products 7.2 6.3 N/A N/A N/A N/A
The following table summarizes the liabilities for these contracts and
policies.
MARCH 31,
------------------------------
(IN MILLIONS) 2004 2003
------------- -------------
Interest-sensitive life $ 6,656 $ 6,131
Fixed annuities - deferred 26,639 21,991
Fixed annuities - immediate 10,130 9,508
Institutional 10,222 8,628
------------- -------------
53,647 46,258
Life-contingent contracts 3,582 2,996
FAS 133 market value adjustment 594 559
Ceded reserves and other 93 105
------------- -------------
Total contractholder funds and reserve for
life-contingent contract benefits $ 57,916 $ 49,918
============= =============
MORTALITY MARGIN is a component of gross margin, both of which are non-GAAP
measures. Mortality margin represents premiums and cost of insurance contract
charges less contract benefits excluding the implied interest on life-contingent
immediate annuities, which is included in the calculation of investment margin.
We use mortality margin to evaluate underwriting performance, as it reflects the
profitability of our products with respect to mortality or morbidity risk during
a fiscal period. Mortality margin by product group is shown in the following
table.
THREE MONTHS ENDED
MARCH 31,
------------------------------
(IN MILLIONS) 2004 2003
------------- -------------
Life insurance $ 91 $ 116
Annuities (23) (28)
------------- -------------
Total mortality margin $ 68 $ 88
============= =============
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE THREE-MONTH PERIOD ENDED MARCH 31, 2004 AND 2003
Mortality margin was $68 million in the first quarter of 2004, reflecting a
$20 million or 22.7% decline compared to the same period of 2003. The decline
was primarily due to the disposal of the majority of our direct response
distribution business, partially offset by improved mortality on our other life
products.
As required by SOP 03-1, as of January 1, 2004, a reserve was established
for guaranteed minimum death benefits ("GMDBs") and guaranteed minimum income
benefits ("GMIBs"), which in previous periods were expensed as paid. Under the
SOP, we anticipate that the mortality margin will be less volatile in the
future, as contract benefit expense will not be impacted by GMDB and GMIB
payments made during each period. For further explanation of the impacts of the
adoption of this accounting guidance, see Note 1 of the Condensed Consolidated
Financial Statements. Included in the mortality margin for the first quarter of
2004 is an addition to the reserve for GMDBs and GMIBs of $15 million, net of
reinsurance. Included in the mortality margin for the first quarter of 2003 are
GMDB and GMIB payments of $21 million, net of reinsurance, hedging gains and
losses and other contractual arrangements.
AMORTIZATION OF DAC AND DSI decreased 28.9% during the first quarter of
2004 compared to the same period of 2003. The decline was primarily attributable
to an acceleration of amortization (commonly referred to as "DAC unlocking")
totaling $89 million in the first quarter of 2003 and the elimination of DAC
amortization on the direct response distribution business sold in January of
2004. These declines were partially offset by higher amortization on
interest-sensitive life and fixed and variable annuities.
The adoption of SOP 03-1 required a new modeling approach for estimating
expected future gross profits that are used when determining the amortization of
DAC. Because of this new modeling approach, effective January 1, 2004, the
variable annuity DAC and DSI assets were reduced by $124 million. This reduction
was recognized as a cumulative effect of a change in accounting principle. For
further explanation of the impacts of the adoption of this accounting guidance,
see Note 1 of the Condensed Consolidated Financial Statements.
OPERATING COSTS AND EXPENSES decreased 15.7% in the first quarter of 2004
compared to the same period of 2003. The following table summarizes operating
costs and expenses.
THREE MONTHS ENDED
MARCH 31,
---------------------------
(IN MILLIONS) 2004 2003
----------- -----------
Non-deferrable acquisition costs $ 31 $ 50
Other operating costs and expenses 71 71
----------- -----------
Total operating costs and expenses $ 102 $ 121
=========== ===========
The decrease in total operating costs and expenses in the first quarter of
2004 compared to the same period of 2003 was primarily due to the disposal of
the majority of our direct response distribution business, which was partially
offset by higher non-deferrable commissions, such as renewal and trail
commissions, and higher employee expenses.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE THREE-MONTH PERIOD ENDED MARCH 31, 2004 AND 2003
INVESTMENTS
The composition of the investment portfolio at March 31, 2004 is presented
in the table below.
PERCENT TO
(IN MILLIONS) INVESTMENTS TOTAL
------------- -------------
Fixed income securities (1) $ 54,317 85.4%
Mortgage loans 6,573 10.3
Equity securities 260 0.4
Short-term 1,319 2.1
Policy loans 682 1.1
Other including derivatives 443 0.7
------------- -------------
Total $ 63,594 100.0%
============= =============
(1) Fixed income securities are carried at fair value. Amortized cost
basis for these securities was $50.20 billion.
Total investments increased to $63.59 billion at March 31, 2004 from $59.99
billion at December 31, 2003 due to positive cash flows from operating and
financing activities, increased unrealized gains on fixed income securities and
increased funds associated with securities lending.
Total investment balances related to collateral, primarily due to
securities lending, increased to $2.47 billion at March 31, 2004, from $1.92
billion at December 31, 2003.
At March 31, 2004, 93.4% of the consolidated fixed income securities
portfolio was rated investment grade, which is defined as a security having a
rating from the National Association of Insurance Commissioners ("NAIC") of 1 or
2; a Moody's equivalent rating of Aaa, Aa, A or Baa; an S&P equivalent rating of
AAA, AA, A or BBB; or a comparable internal rating, when an external rating is
not available.
The unrealized net capital gains on fixed income and equity securities at
March 31, 2004 were $4.12 billion, an increase of $941 million or 29.6% since
December 31, 2003. The net unrealized gain for the fixed income portfolio
totaled $4.12 billion, comprised of $4.28 billion of unrealized gains and $159
million of unrealized losses at March 31, 2004. This is compared to a net
unrealized gain for the fixed income portfolio totaling $3.18 billion at
December 31, 2003, comprised of $3.47 billion of unrealized gains and $294
million of unrealized losses. Of the gross unrealized losses in the fixed income
portfolio at March 31, 2004, 57.9% were concentrated in the corporate fixed
income portfolio. The losses were primarily comprised of securities in the
transportation, basic industry and consumer goods sectors. The gross unrealized
losses in these sectors were primarily company specific or interest rate
related. Approximately 20.7% of the gross unrealized losses on the corporate
fixed income portfolio were associated with the airline industry for which
values were depressed due to company specific issues and economic issues related
to fuel costs. While we expect eventual recovery of these securities and the
related sectors, we included every security in our portfolio monitoring process.
The net unrealized gain for the equity portfolio totaled $4 million,
comprised of $6 million of unrealized gains and $2 million of unrealized losses
at March 31, 2004. This is compared to a net unrealized gain for the equity
portfolio totaling $4 million at December 31, 2003. The consumer goods and
technology sectors had the highest concentration of gross unrealized losses in
the equity portfolio, which were primarily company and sector specific. While we
expect eventual recovery of these securities and these sectors, we included
every security in our portfolio monitoring process.
Our portfolio monitoring process identifies and evaluates fixed income and
equity securities whose carrying value may be other than temporarily impaired.
The process includes a quarterly review of all securities using a screening
process to identify those securities whose fair value compared to cost for
equity securities or amortized cost for fixed income securities is below
established thresholds for certain time periods, or which are identified through
other monitoring criteria such as ratings downgrades or payment defaults.
We also monitor the quality of our fixed income portfolio by categorizing
certain investments as "problem", "restructured" or "potential problem." Problem
fixed income securities are securities in default with respect to principal or
interest and/or securities issued by companies that have gone into bankruptcy
subsequent to our acquisition of the security. Restructured fixed income
securities have rates and terms
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE THREE-MONTH PERIOD ENDED MARCH 31, 2004 AND 2003
that are not consistent with market rates or terms prevailing at the time of the
restructuring. Potential problem fixed income securities are current with
respect to contractual principal and/or interest, but because of other facts and
circumstances, we have serious concerns regarding the borrower's ability to pay
future principal and interest, which causes us to believe these securities may
be classified as problem or restructured in the future.
The following table summarizes problem, restructured and potential problem
fixed income securities.
(IN MILLIONS) MARCH 31, 2004 DECEMBER 31, 2003
--------------------------------------- ---------------------------------------
PERCENT OF PERCENT OF
TOTAL FIXED TOTAL FIXED
AMORTIZED FAIR INCOME AMORTIZED FAIR INCOME
COST VALUE PORTFOLIO COST VALUE PORTFOLIO
----------- ----------- ----------- ----------- ----------- -----------
Problem $ 150 $ 147 0.3% $ 167 $ 155 0.3%
Restructured 24 27 0.1 32 35 0.1
Potential problem 255 262 0.4 259 255 0.5
----------- ----------- ----------- ----------- ----------- -----------
Total net carrying value $ 429 $ 436 0.8% $ 458 $ 445 0.9%
=========== =========== =========== =========== =========== ===========
Cumulative write-
downs recognized $ 248 $ 228
=========== ===========
We have experienced a decrease in the amortized cost of fixed income
securities categorized as problem, restructured and potential problem as of
March 31, 2004 compared to December 31, 2003. The decrease was primarily related
to the sale of holdings in these categories due to specific developments causing
a change in our outlook and intent to hold those securities.
We also evaluated each of these securities through our portfolio monitoring
process and recorded write-downs when appropriate. We further concluded that any
remaining unrealized losses on these securities were temporary in nature. While
these balances may increase in the future, particularly if economic conditions
are unfavorable, we expect that the total amount of securities in these
categories will remain low relative to the total fixed income securities
portfolio.
NET REALIZED CAPITAL GAINS AND LOSSES The following table presents the
components of realized capital gains and losses and the related tax effect.
THREE MONTHS ENDED
MARCH 31,
------------------------
(IN MILLIONS) 2004 2003
---------- ----------
Investment write-downs $ (34) $ (57)
Sales 35 15
Valuation of derivative instruments (20) (6)
Settlement of derivative instruments (8) 6
---------- ----------
Realized capital gains and losses, pretax (27) (42)
Income tax benefit 10 16
---------- ----------
Realized capital gains and losses, after-tax $ (17) $ (26)
========== ==========
We may sell securities during the period in which fair value has declined
below amortized cost for fixed income securities or cost for equity securities.
Recognizing in certain situations new factors such as negative developments,
subsequent credit deterioration, relative value opportunities, market liquidity
concerns and portfolio reallocations, we can subsequently change our previous
intent to continue holding a security. Sales in the above table also include
dispositions such as call and prepayment transactions.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE THREE-MONTH PERIOD ENDED MARCH 31, 2004 AND 2003
CAPITAL RESOURCES AND LIQUIDITY
CAPITAL RESOURCES consist of shareholder's equity, representing funds deployed
or available to be deployed to support business operations. The following table
summarizes our capital resources.
(IN MILLIONS) MARCH 31, 2004 DECEMBER 31, 2003
------------------ ------------------
Redeemable preferred stock $ 82 $ 82
Common stock, retained earnings and other
Shareholder's equity items 5,185 5,294
Accumulated other comprehensive income 1,216 1,053
------------------ ------------------
Total shareholder's equity $ 6,483 $ 6,429
================== ==================
SHAREHOLDER'S EQUITY increased in the first quarter of 2004 when compared
to December 31, 2003, as increases in unrealized net capital gains on
investments were partially offset by a net loss for the first quarter of 2004
and a dividend to Allstate Insurance Company ("AIC") of $25 million.
DEBT as of March 31, 2004 and December 31, 2003 amounted to $45 million and
reflects the debt of an investment security consolidated under the provisions of
Financial Accounting Standards Board Interpretation No. 46. Although we are
required to consolidate this security, we have no legal ownership of the assets
and no obligation to repay the debt. The holders of this debt have no recourse
to the equity of the Company, as the sole source of payment of the liabilities
is the assets that comprise the investment security.
We have an intercompany loan agreement with The Allstate Corporation (the
"Corporation") whereby the amount of intercompany loans available is at the
discretion of the Corporation. The maximum amount of loans the Corporation will
have outstanding to all its eligible subsidiaries at any given point in time is
limited to $1.00 billion. We had no amounts outstanding under this agreement at
March 31, 2004 or 2003.
FINANCIAL RATINGS AND STRENGTH Our ratings are influenced by many factors
including our operating and financial performance, asset quality, liquidity,
asset/liability management, overall portfolio mix, financial leverage (i.e.,
debt), exposure to risks such as catastrophes and the current level of operating
leverage. There have been no changes to our insurance financial strength ratings
since December 31, 2003. However, in February 2004, A.M. Best revised the
outlook to stable from positive for the insurance financial strength ratings of
the Company and certain rated subsidiaries and affiliates.
LIQUIDITY SOURCES AND USES As reflected in our Condensed Consolidated Statements
of Cash Flows, lower operating cash flows in the first quarter of 2004 when
compared to the first quarter of 2003 primarily relate to declines in premiums,
partially offset by increases in investment income. Cash flows used in investing
activities increased in the first quarter of 2004 as the investment of higher
financing cash flow was partially offset by lower operating cash flows.
Higher cash flow from financing activities during the first quarter of 2004
when compared to the first quarter of 2003 reflects an increase in deposits
received from contractholders, partially offset by maturities of institutional
products and benefits and withdrawals from contractholders' accounts. For
quantification of the changes in contractholder funds, see the Operations
section of the MD&A.
We have access to additional borrowing to support liquidity through the
Corporation as follows:
- - A commercial paper program with a borrowing limit of $1.00 billion to cover
short-term cash needs. As of March 31, 2004, the remaining borrowing
capacity was $975 million; however, the outstanding balance fluctuates
daily.
- - Two primary credit facilities and one additional credit facility totaling
$1.20 billion to cover short-term liquidity requirements. These consist of
a $575 million five-year revolving line of credit expiring in 2006, a $575
million 364-day revolving line of credit expiring in the second quarter of
2004 and a $50 million one-year revolving line of credit expiring in the
third quarter of 2004. The right to borrow under the five-year and 364-day
facilities is subject to requirements that are customary for facilities of
this size, type and purpose. These requirements are currently being met and
we expect to continue to meet them in the future. There were no borrowings
under any of these lines of credit during the first quarter of 2004. The
total amount outstanding at any point in time under the combination of the
commercial paper program and the three credit facilities is limited to
$1.20 billion.
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE THREE-MONTH PERIOD ENDED MARCH 31, 2004 AND 2003
- - The right to issue up to an additional $2.80 billion of debt securities,
equity securities, warrants for debt and equity securities, trust preferred
securities, stock purchase contracts and stock purchase units utilizing the
shelf registration statement filed with the Securities and Exchange
Commission ("SEC") in August 2003.
FORWARD-LOOKING STATEMENTS
This document contains "forward-looking statements" that anticipate results
based on our estimates, assumptions and plans that are subject to uncertainty.
These statements are made subject to the safe-harbor provisions of the Private
Securities Litigation Reform Act of 1995. We assume no obligation to update any
forward-looking statements as a result of new information or future events or
developments.
These forward-looking statements do not relate strictly to historical or
current facts and may be identified by their use of words like "plans," "seeks,"
"expects," "will," "should," "anticipates," "estimates," "intends," "believes,"
"likely," "targets" and other words with similar meanings. These statements may
address, among other things, our strategy for growth, product development,
regulatory approvals, market position, expenses, financial results, litigation
and reserves. We believe that these statements are based on reasonable
estimates, assumptions and plans. However, if the estimates, assumptions or
plans underlying the forward-looking statements prove inaccurate or if other
risks or uncertainties arise, actual results could differ materially from those
communicated in these forward-looking statements. Factors which could cause
actual results to differ materially from those suggested by such forward-looking
statements are incorporated in this Part I, Item 2 by reference to the
information set forth in our Annual Report on Form 10-K, Part II, Item 7, under
the caption "Forward-Looking Statements and Risk Factors."
23
ITEM 4. CONTROLS AND PROCEDURES
With the participation of our principal executive officer and principal
financial officer, we carried out an evaluation of the effectiveness of the
design and operation of our disclosure controls and procedures as of the end of
the period covered by this report. Based upon this evaluation, the principal
executive officer and the principal financial officer concluded that our
disclosure controls and procedures are effective in timely alerting them to
material information required to be included in our periodic reports filed with
the Securities and Exchange Commission. However, the design of any system of
controls and procedures is based in part upon assumptions about the likelihood
of future events and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions, regardless of
how remote. Our disclosure controls and procedures are designed to provide
reasonable assurance of achieving their objectives and are effective at the
"reasonable assurance" level.
During the fiscal quarter ended March 31, 2004, there have been no changes
in our internal control over financial reporting that have materially affected,
or are reasonably likely to materially affect, our internal control over
financial reporting.
24
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Information required for this Part II, Item 1, is incorporated by reference to
the discussion under the heading "Regulation" and under the heading "Legal
proceedings" in Note 3 of the Company's Condensed Consolidated Financial
Statements in Part I, Item 1 of this Form 10-Q.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
An Exhibit Index has been filed as part of this report on page
E-1.
(b) Current Reports on Form 8-K were filed during the first quarter
of 2004 on the following dates for the items indicated:
March 4, 2004, Item 9, regarding results of operations and
financial condition for the quarter ended December 31, 2003.
25
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Allstate Life Insurance Company
(Registrant)
May 6, 2004 By /s/ Samuel H. Pilch
--------------------
Samuel H. Pilch
(chief accounting officer and duly
authorized officer of the Registrant)
26
EXHIBIT NO. DESCRIPTION
----------- -----------
15 Acknowledgment of awareness from Deloitte & Touche LLP,
dated May 7, 2004, concerning unaudited interim
financial information.
31.1 Rule 13a-14(a) Certification of Principal Executive
Officer
31.2 Rule 13a-14(a) Certification of Principal Financial
Officer
32 Section 1350 Certifications
E-1